Debt Saturation and Money Illusion

Most of the clearly evident financial problems that surround us today stem
from one cause - Debt Saturation.

Most, intuitively, sense this to be a correct assessment but few can either
prove it or articulate it to the less sophisticated. Let me arm you to be the "Nostradamus" amongst
your friends and colleagues in explaining the problem and what the future therefore
foretells.

However, let me make it very clear, this will not make you popular. Smart
maybe, but highly likely to make you unwanted at the social gatherings of the
genteel.

The first thing you will need in your role of 'all seeing' is the back of
an envelope, or a somewhat clean napkin at your next luncheon. You will need
only a few simple facts to go along with your prop.

THE FACTS MAME, JUST THE FACTS!

First, if you could total the world's balance sheets you would find that it
would approximate $200 Trillion. In putting together this total you would discover
that 75% of all financial assets are debt assets worth $150 Trillion. To most
of us, debt is the epitome of a liability. To banks, however, it is not. It
is considered an asset and recorded as such a banks ledger. Your liability
is their asset.

The historical debt payment over a long period of time is 6% per annum. The
Federal Reserve's dividend payment to its holders of capital was originally
established in 1913 at precisely this 6% and is still accrued accordingly.
Remember also, in a fractional reserve, fiat based banking system money can
only be loaned into existence.

Today we have approximately $9 Trillion (6% of $150T) in annual debt payments
that must be absorbed annually by increased productivity of the working classes.

Consider that the US Economy at approximately $15 Trillion is 25% of the global
economy. Therefore the global economy approximates $60 Trillion ($62T officially,
but we will use round numbers so we don't lose anyone in the arithmetic).

The working class therefore has to increase productivity by $9T divided by
$60T or 15% annually to absorb the current global usury charges.

In the last few years of explosive debt growth we have passed the point of
the global economy being able to grow and improve productivity at a fast enough
rate, not to be literally consumed by this existing debt burden.

Unfortunately, it gets worse.

One of the problems in using GDP as a measure of growth is that it includes
government spending. In the case of the US, it is approaching 25% of the output
of the country. Within that, approximately $3.7 Trillion is $490B in interest
payments or 13% of US expenditures. This actually

means that there is an additional 3% that must be added to the 15% or nearly
18%.

This is called Debt Saturation.

DIMINSHING MARGINAL PRODUCTIVITY.

A very unpopular chart to deficit spending hawks is the chart showing the
change in GDP as a ratio to the change in debt. The easiest way to understand
this chart is to consider how much the economy will grow for every dollar of
increased debt. As you can see, the effect of increased debt has been steadily
losing its ability to increase economic growth and since the financial crisis
has decidedly turned negative.

Increased debt is now counterproductive to the growth of the economy because
the economy simply does not have sufficient productive investments to absorb
it. We may have plenty of investments but they are mal-investments. They are
investments that simply cannot pay the debt financing utilized.

The Korean Times recently
illustrated that despite a booming Asian environment, technology firms
are now struggling to cover interest payments. One in three firms on the
Kosdaq failed to earn sufficient money to cover interest payments in 2010.
The interest coverage ratio, otherwise dubbed times interest earned (TIE),
refers to the measure of a firm's ability to honor its debt payments. 280
out of 876 Kosdaq-listed outfits, or 32 percent, could not reach the benchmark
reading of one in the interest coverage ratio.

TELLTALES OF DEBT SATURATION:

1- Non Performing Loans

The mal-investment is just too large to contain and is showing up in ever-increasing
levels of non-performing loans. This is despite rolling over loans at false
asset values.

Non-performing bank assets are increasing globally! The above chart from Reggie
Middleton's BoomBustBlog graphically depicts this indisputable trend. What
is this signaling three years after the financial crisis?

NON PERFORMING ASSET GROWTH

2005

2010

CHANGE

GREECE

6.3%

9.0%

+2.7%

HUNGARY

2.3%

7.8%

+5.5%

SPAIN

0.8%

7.6%

+6.6%

ROMANIA

2.6%

17.5%

+14.9%

CENTRAL & EASTERN EUROPE

4.5%

11.5%

+7.0%

USA

0.8%

10.3%

+9.5%

WORLD AVERAGE

5.9%

7.6%

+1.7%

The rise in the above US non-performing assets is alarming. It reflects a
9.5% change since 2005. Everything is not at all well in the US banking sector.

Equally concerning is what is happening in Central and Eastern Europe where
the change is 7%. I personally consider Central and Eastern Europe to be the
unaddressed 'sub-prime' problem of Europe. I suspect it will eventually replace
the PIIGS in financial media news coverage.

2- Chronic Unemployment

The money lenders look at unemployment in a different fashion than the average
person and would have us easily confused by its adjustments, birth-death models
and other deceiving statistics. To them it is not about how many of our fellow
citizens are unemployed, but rather simply how many net new jobs are being
created to pay for the annual usury assessment fee of the $9 Trillion we previously
discussed. Herein lies their problem.

The internet has had a profound impact on the increase in productivity. Schumpeter's
creative destruction is an engine running at full throttle. Vast swaths of
jobs are being made obsolete through the adoption of new technology. The 'clerical'
industry has almost disappeared in the span of 15 years through operational
innovations such as supply chains. This has been tremendous for corporate profits
allowing them to maintain highly leveraged balance sheets. The problem is that
it has been solely at the expense of real job growth. No matter what a corporation
does to make money, it eventually comes down to a consumer having the money
to pay for the goods or services it produces.

We have reached the saturation point where we have insufficient real income
growth to maintain the leveraged balance sheets of corporations. Government
social nets are becoming burdened with making up the difference in either transfer
payments (i.e.45 Million on food stamps in the US) or subsidies ( North Africa
paying 28% of country budgets toward food subsidies for the unemployed population
to survive). There are examples everywhere if you care to look. I have written
extensively on this in my series on Innovation and
in articles such as "Fearing
the Gearing".

3- Money Velocity Doesn't Increase with Money Printing

Debt Saturation occurs when aggregate income no longer supports debt burdens.
When governments print money, eventually Money Velocity increases as people
incorporate inflation expectations into their buying behavior. When we examine
the Federal Reserve's Money Velocity statistics we see that something is very
different this time.

We presently have inflation in what people NEED along with shrinking real
disposable incomes. Since people must pay for their NEEDS with short term money
(cash, check or credit card), there is little ability for them to adjust to
inflation when they are living from paycheck to paycheck. If their disposable
incomes were higher they would stockpile and turn their money over faster.
Additionally, money as a multiplier would flow through our society. Instead,
today the money does not move through multiple hands but is returned almost
immediately to the banks as debt payment, since most intermediaries are also
burdened with debt.

WHAT YOU MUST BE AWARE OF

First, You must understand the impact of mal-investments and the brake
that debt is now applying to the Global Economy.

World Real GDP, adjusted for inflation on a year-over-year basis has plummeted.
According to the World Bank this growth indicator has gone negative with the
world's real GDP actually shrinking Y-o-Y.

The global growth engine has not only stalled but has clearly hit an unexpected
brick wall.

Secondly, You must understand the significance of the stalled and possibly
fatally ill "Shadow Banking" Credit Engine.

Similar to moving about on an airplane or train it is hard to determine the
speed you are traveling, because you have a limited

frame of reference. In a casual conversation with your fellow travelers it
is easily forgotten or unnoticed that you are moving at a rapid speed. This
is the situation we find ourselves in as the Shadow Banking System fails to
rebound and the debt it once created is not being replaced. The liabilities
of the Shadow Banking System are shrinking. These leveraged liabilities are
now shrinking the global money supply despite every effort of central banks
to combat it. The Central Banks are losing the battle. Like glacial tectonic
shifts they are undermining the abilities of financial institutions to continue
to carry and roll-over non performing debt.

Finally, You Must be Aware of: "Money Illusion"

The overlay below of the Nominal and Real (ShadowStats inflation-adjusted)
Dow illustrates the concept of Money
Illusion, the tendency of people to think of currency in nominal, rather
than real, terms. Below the Dow series is the Consumer Price Index (CPI) from
1913 and with estimates for the earlier years.

The above chart reflects what is actually going on in the financial markets.
The secular bear market that began in 2000 is still underway. Since the 2009
lows we are experiencing a Cyclical Bull Market counter rally that is to be
fully expected as part of a Secular Bear Market.

The chart to the right is adjusted for inflation based on published CPI numbers.
If ShadowStats inflation numbers are used, as is the case in the above chart,
then the chart to the right would more clearly resemble longer term secular
bear markets already experienced.

CONCLUSION

There is nothing magic in any of this and it has all been well documented,
unfortunately by the Russians when they studied the capitalist system to identify
its fundamental weaknesses. The Kondratieff long wave shows that the capitalist
system suffers the build up and purging of debt on a generational basis on
the frequency approaching 55 year cycles. We have extended this natural cycle
by means of un-natural acts which I have written about in my extensive "Extend & Pretend" series
of articles. Even in the days of old the king resorted to "jubilee" to cleanse
the system. Of course we are much too sophisticated for such a simple solution
today.

We have papered over the realities of "Too Big to Fail" by not allowing the
proven tenets of capitalism to work. We have Anti-trust laws under the Sherman
act to address 'too big', Control Fraud Laws to address questionable ethical
behavior for the sake of profit (like mortgage fraud, liars loans etc) and
Bankruptcy laws to liquidate failed enterprises to force debt holders to take
haircuts and swap debt for equity. Instead we allow the prevalent game of Regulatory
Arbitrage to run without restriction or detection. Existing laws are not being
exercised in an attempt to protect what amounts to the emergence of a crony
capitalist system. Benito Mussolini had a somewhat different world for the
merging of corporate and government interests that I will leave for readers
to recollect who have a historical penchant. It is not a word easily digested
in the polite 'cocktail chatter' of today's genteel upper middle class.

Welcome to Kondratieff's Long Wave Cycle

FORETELLING THE FUTURE

In your new role as 'Nostradamus' to your friends you can safely predict a
decade ahead to be a secular bear market in financial assets, in real terms.
Nominal values may not show this clearly but it will be very evident in the
reduced standard of living most Americans will experience.

You are going to have to work harder and harder, for less and less to survive
at a lower and lower standard of living.

This will all be required to support the annual $9T debt bondage we have assumed
as our politicos add additional 'stimulus' to a suffocating and debt saturated
global economy.

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Gordon T. Long has been publically offering his financial and economic writing
since 2010, following a career internationally in technology, senior management & investment
finance. He brings a unique perspective to macroeconomic analysis because
of his broad background, which is not typically found or available to the
public.

Mr. Long was a senior group executive with IBM and Motorola for over 20 years.
Earlier in his career he was involved in Sales, Marketing & Service of
computing and network communications solutions across an extensive array of
industries. He subsequently held senior positions, which included: VP & General
Manager, Four Phase (Canada); Vice President Operations, Motorola (MISL -
Canada); Vice President Engineering & Officer, Motorola (Codex - USA).

After a career with Fortune 500 corporations, he became a senior officer of
Cambex, a highly successful high tech start-up and public company (Nasdaq:
CBEX), where he spearheaded global expansion as Executive VP & General
Manager.

In 1995, he founded the LCM Groupe in Paris, France to specialize in the rapidly
emerging Internet Venture Capital and Private Equity industry. A focus in
the technology research field of Chaos Theory and Mandelbrot Generators lead
in the early 2000's to the development of advanced Technical Analysis and
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Mr. Long presently resides in Boston, Massachusetts, continuing the expansion
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Gordon T. Long is a graduate Engineer, University of Waterloo (Canada) in
Thermodynamics-Fluid Mechanics (Aerodynamics). On graduation from an intensive
5 year specialized Co-operative Engineering program he pursued graduate business
studies at the prestigious Ivy Business School, University of Western Ontario
(Canada) on a Northern & Central Gas Corporation Scholarship. He was subsequently
selected to attend advanced one year training with the IBM Corporation in
New York prior to starting his career with IBM.

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